exchange rate basics Flashcards
(13 cards)
What is the exchange rate (S)
the price of a domestic currency relative to foreign currency
What happens when S increases of home currency
The home currency depreciates, and the foreign currency appreciates
What happens when S decreases of home currency
The home currency appreciates, and the foreign currency depreciates
What is the difference between bilateral and trade-weighted exchange rates
Bilateral exchange rates compare two currencies directly
trade-weighted exchange rates account for multiple currencies based on trade proportions
What are spot and forward exchange rates
Spot rates apply to immediate currency exchanges
forward rates are pre-agreed for future transactions
What factors influence the demand for foreign exchange
Imports, outgoing foreign investment, and speculation
What factors influence the supply of foreign exchange
Exports, incoming foreign investment, and speculation
What happens when the demand curve for foreign exchange shifts right
There is an excess demand for foreign currency, leading to appreciation of the foreign currency and depreciation of the home currency
What is a freely floating exchange rate
It is determined exclusively by supply and demand without central bank intervention
How does a government maintain a fixed exchange rate
By intervening in the foreign exchange market, buying or selling currencies to hold the exchange rate steady
Why is a fixed exchange rate incompatible with independent monetary policy
Because maintaining a fixed exchange rate requires interventions that affect the money supply, limiting monetary policy flexibility
What is sterilization in exchange rate policy
A process where the central bank offsets the impact of currency interventions on the money supply through open market operations
What are common exchange rate systems today
Most countries use a managed or “dirty” float, where exchange rates are influenced by government interventions
